Excessive foreign capital outflow has had a significantly negative impact on South Korean market. Reflecting on the 1997-1998 Asian financial crises and the 2008 global financial crisis, the government has put more emphasis on preventing inordinate amount of foreign capital flow from coming into domestic market. Unexpected external shocks including global crisis followed by an abrupt withdrawal of foreign currency created instability and volatility in Foreign Exchange and Rate markets.
In order to restrain foreign loans from growing rapidly, the Bank of Korea announced that financial firms are banned to buy foreign currency-denominated bonds so called “Kimchi bonds” issued for local use. With the word, “Kimchi” which refers to Korean side-dish, and “bond” combined, Kimchi bonds are foreign currency-denominated bonds sold by foreign and domestic companies in Korea. The bonds were originally for companies that need foreign currency within the country. Since raising foreign capital is handy with Kimchi bonds, the bonds are allegedly a useful tool for firms to invest overseas and make a payment for imported goods.
More and more companies, however, tend to invest in Kimchi bonds with the intention to swap proceeds into Won, the currency of South Korea. Although they are apparently of no relationship with U.S., having no reason to hold dollars, they are likely to issue Kimchi bonds to raise funds at a cheaper price. Since foreign loans feature lower interest rates than domestic loans, companies can easily take advantages through the swap market. With banks acting as counterparts, a surge of short-term overseas debt would result in a stronger won as the amount of dollar on sale is increasing. Also the chances are that foreign capital inflows could withdraw quickly from the peninsula at times of external shocks, making Korean currency, won more susceptible to external blow. According to an online news provider, about two thirds of $6 billion in Kimchi bonds issued this year were issued only for local use on April. Local and foreign banks’ branches borrowed short-term debts from overseas to purchase Kimchi bonds or to hedge foreign exchange forward positions. Abuse of Kimchi bonds can distort the overall financial market nationwide.
Consequently, financial authorities including Bank of Korea, Financial Services Commission, Ministry of Strategy and Finance, and Financial Supervisory Service, requested firms to refrain from enjoying private placements of bonds for domestic use. Tightened rule on handling Kimchi bonds delineates that banks can only provide loans in foreign capital if borrowers need funds for overseas use. So starting from July 25th, purpose of investment in Kimchi bonds written in securities-related document, should be screened thoroughly in advance whenever domestic financial firms buy the bonds, according to BOK. In addition, limits have been imposed on the amount of foreign-exchange forwards positions that local banks can carry relative to their capital.
As an effort to minimize the destabilizing impacts of rapid foreign capital flows in and out of national markets, newly released regulation which curtails the abuse of Kimchi bonds has come into effect. After the policy being declared, the number of Kimchi bonds issued has dramatically declined in the past few months.
The governmental action is an attempt to improve transparency and reduce volatility in Foreign Exchange market since 2008 financial crisis. In regard to this attempt, some people can argue that some companies might fear it will become harder to raise funds at any time they want to make overseas expenditure. Yet, there are many other channels available to raise funds, such as by using banking loans, corporate bonds, or taking on longer-term loans to reduce vulnerability in industry. Therefore, controlling Kimchi bonds issuance as a preventative measure against ‘blindly profit-pursuing’ companies would have an insignificant influence on a majority of market players.
By Ki Yeon Lee